Monday, June 5, 2017

A Belated Reply to Janet Yellen's 1980 Critique of Post-Keynesian Economics

Brad Delong is in the excellent habit of reposting some of his older pieces, including a ten-year old post entitled “Keynesian Economicses and the Economicses of Keynes.”  Although Brad doesn’t mention it in his 2007 post, Janet Yellen wrote a harsh critique of Post-Keynesian economics in 1980, which was entitled “"On Keynesian Economics and the Economics of the Post-Keynesians".  I read Yellen’s 1980 paper recently and decided to write a reply. Here’s the abstract:

"Thirty years before Janet Yellen became Chair of the U.S. Federal Reserve, she wrote a blistering polemic entitled 'On Keynesian Economics and the Economics of the Post-Keynesians' (1980).  Ms Yellen criticized the Post-Keynesian theory of output and income distribution, vigorously defended the neoclassical synthesis, and extolled the virtues of the 'standard Keynesian IS-LM model.'  In this belated reply, I respond to Yellen’s criticisms of Post-Keynesian economics, expose some flaws in her own distinctive version of the IS-LM model, and outline a few implications of Ms Yellen’s ironic epiphany, 'A Minsky Meltdown: Lessons for Central Bankers” (2009)' for contemporary debates in macroeconomics."

Thursday, June 2, 2016

Seattle Pension Fund to Shield its Private Equity Partners from Public Disclosure

Last year, the Seattle Pension System tripled its investment in Private Equity, an asset class known for its tax loopholes, controversial business practices, and lack of transparency. This year Seattle lobbied the State Legislature seeking to shield its Private Equity managers from public scrutiny.

And in a few weeks, the City will get its wish. After June 27, 2016, the public pension systems of Seattle, Tacoma, and Spokane will have the authority to reject public disclosure requests concerning the fees and expenses they pay their Private Equity partners (here).

Now, bearing in mind that Seattle was the first big city to adopt a $15/hour minimum wage, doesn't it seem a bit odd that this Citadel of Liberalism and Democratic Socialism would so tightly embrace an investment class that's been described as a vehicle for transferring wealth to the 0.1%?

Why did the City of Seattle capitulate? According to the Retirement Board's April 14, 2016 minutes, the new public disclosure exemption will give Seattle's pension system "greater access to top private fund managers." Why? Because "some [Private Equity] managers have told staff they were not interested unless they were an exception [to public disclosure requirements]."

Shielding Private Equity managers from public scrutiny is not a trivial matter, and I should like to ask Seattle's Mayor and City Council, "How much more expected revenue is required to gain the City's cooperation in concealing Private Equity fees from the public?"

The Private Equity industry claims it needs secrecy to protect its sophisticated analytical techniques from competitors. But a more plausible explanation can be found in a recent study by the Securities and Exchange Commission (SEC), which revealed that more than 50% of a large sample of Private Equity firms were overcharging investors (see here). According to a recent study by Oxford professor, Ludovic Phalippou, "Private equity firms have charged hidden fees amounting to $20 billion to companies" (see here, here, and here).

The SEC findings are actually small potatoes compared with Seattle's own Private Equity misadventures. A few years ago, the City went to court simply to get information on its $20 million investment in Epsilon II, with offices in the Cayman Islands, and a Ponzi scheme stretching all the way to Minnesota (see here). The judge rejected the City's plea, mocking Seattle for demanding transparency after the City's Pension Fund had placed a $20 million bet on "a foreign investment that by its own terms provided for only minimal transparency."

"But this is just one case," it will be objected. The chart below displays Seattle's Private Equity returns compared with Vanguard's low cost Small Cap Growth Index Fund for periods ending on 12/31/2015.

Granted, even the 7-year period in the graph is too short to rule out "bad luck" as the primary cause of Seattle's poor performance. On the other hand, the average annualized returns of Seattle's Private Equity portfolio would be significantly lower than the returns shown in the chart if the SEC and Oxford findings apply to Seattle. If Seattle is confident that its Retirement System isn’t paying any bogus fees to its Private Equity partners, then why not disclose these fees to the public?

Recall to mind the Financial Crisis, Mitt Romney and Bain Capital, Occupy Seattle, the 1% and the 99%. Thinking globally, the City of Seattle publicly condemned “unjust tax systems” and expressed grave concern about “growing income disparity” in Resolution 31337. But acting locally, Seattle officials doubled down on the City's investment in an industry that thrives on “unjust” tax loopholes and is front-and-center in the march toward greater inequalities of wealth and income.

Not to put too fine a point on it, but Seattle's commitment to Private Equity – with both the City's dollars and its readiness to shield its Private Equity partners from public disclosure – is an affirmation of the very same economic arrangements Seattle's elected officials criticized so sharply after the Occupy Seattle protests – special tax loopholes for the 0.1%, increased inequalities of wealth and income, and the distorting influence of big money in politics.

Wednesday, March 2, 2016

Unravelling Some Occult Mysteries of the Heterodox

Noah Smith has a new post, "Occult Mysteries of the Heterodox," criticizing Heterodox economists who seem unable to provide a simple explanation of their new, and supposedly superior, methodologies. “They show every indication of having no new methodology whatsoever.”  And later, in a "tweetstorm," Noah accuses Post Keynesians, in particular, of only being interested in methodologies that yield their favored conclusions.

In contrast to the the PKs, who offer nothing but "criticism," Noah points to “the Solow Growth model” as a useful and accessible scheme of analysis.  I’ll get to alternatives in a moment, but I think Noah is much too blasé about the importance of “criticism,” and his reference to “the Solow Growth model” provides a good illustration of the problem.

Leaving aside the Cambridge (UK) critique of aggregate production functions (the mere mention of which brands one a hopeless ideologue), here’s a brief paper by Jesus Felipe and Franklin M. Fisher, who carefully explain the conceptual difficulties with aggregate production functions and then patiently respond to all the justifications offered by those who still use these models despite their drawbacks.  

Some defenders of mainstream economics brush off critics, claiming they just don't know the math.  Well, Kenneth Arrow and Robert Solow, who do know the math, haven't been impressed by the modeling inspired by Lucas and Sargent.  Perhaps Stephen Williamson is right to dismiss these critics because they “fail to understand the power of the work they did,” but this claim requires an argument that addresses the actual criticisms offered by Arrow and Solow, not to mention those of Frank Hahn, Franklin M. Fisher, and several other first-class economists.

Noah is mistaken when he says PKs simply favor the methods that will produce their favorite conclusions.  I think, in opposition to Noah's view, that PK approaches and methods arise from their criticisms of orthodoxy.  

For brevity’s sake, I’m going to mention one assumption widely held among PKs, which is that neither market participants nor economists “know the data-generating process.”  Awhile ago, Brad DeLong, commenting on a Lars P. Syll post, granted that there may be something worthwhile in this point of view, but asked, “what kind of economic arguments do we make” once this assumption is accepted?

Here’s a short list of the sort of practical ramifications of assuming that neither market participants nor economists know "the data-generating process."

1. First, let me note that our ignorance is manifest in the disagreement among economists about the causes of the Financial Crisis and the Great Recession, the effects of QE on interest rates and inflation, etc.  Such disagreement gives rise to many, often inconsistent, beliefs about the economy, and this diversity of beliefs must be taken into account in thinking about the economy.  Isn't it worth modeling economies in which market participants hold conflicting views of the future?  Wouldn't such an economy behave differently from one in which everyone shares the same rational expectations?  Mordecai Kurz has done interesting work in the area. And agent-based modeling (Santa Fe style) may prove useful in thinking about interactions among agents with different “views of the world.”

2. If you don’t know how “the data-generating process” works, or if there is no such thing, then history, path dependence, and hysteresis should play a larger role in thinking about the economy.

3. Since agents don't possess a complete list of states and their probabilities of occurrence, many people rely on verbal models, narratives, and stories to guide their economic decision making, and the role these informal “models” deserve examination.  See some of Robert Shiller’s recent work as well as this paper, which finds the EMH wanting once "the news" is taken into account.

4. Disequilibrium micro foundations (and mutually inconsistent expectations) attracted a lot of first-class economists from the mid-1950s until the early 2000s, including Hicks, Debreu, Hahn, Samuelson, Clower, Leijonhufvud, Negishi, and several others.  Arrow, himself, thought of the macroeconomy as "a disequilibrium phenomenon," and this vantage point is worth another look.  R. Backhouse and M. Boianovsky wrote a good book on the subject.

It may be objected that the economists mentioned above are not Post Keynesians, or at least do not identify themselves as such.  I concede this point because I’m concerned with methods and approaches that avoid some of shortcomings of mainstream thinking, rather than with the purity of Post-Keynesian economies.

Monday, January 11, 2016

What's at the Bottom of Ted Cruz's Fantasy Spanking of Hilary Clinton

Ted Cruz seems like a rational fellow, but David Brooks claims that Cruz’s world is “combative,” “angry,” and “apocalyptic,” his speeches full of “dark and satanic tones.” I rarely agree with Brooks, but there is something “dark” in Cruz's telling voters to “spank” Hilary Clinton like Cruz spanks his 5-year old daughter.

On the surface, spanking is just a way to discourage bad behavior. But beneath the surface, after the child’s buttocks have been exposed to the same parent who teaches “modesty,” and the shame is comingled with the pain, we get a glimpse of the erotic origins of masochism and of adult bullies and abusers who reenact their childhood punishments by becoming “punishers” themselves.  

Sometimes when children are spanked, they don't respond at all.  Their facial expression exhibits nothing, no feeling whatsoever.  I've never seen Cruz's daughter's face during the spankings Cruz finds so pleasing, but I have seen the out-takes of some Cruz-for-President ads involving his family, and their interaction doesn't contradict David Brooks' portrait of Cruz as a man whose words are imbued with "dark and satanic tones."

Tuesday, September 29, 2015

Rational Expectations and the Microfoundations of Autonomy

One aspect of modern economies that deserves more attention is the variety of beliefs that inform the decision making of households, firms, and governments.  Every asset market includes bulls who believe prices will rise and bears who believe they will fall.  Central banks and national governments draw on diverse macroeconomic models in their policy making, which is evident in the conflicting predictions about the effects of quantitative easing.  And Nobel Prizes in economics have been awarded to economists advancing sharply divergent theories, the most recent example being the 2013 Prizes awarded to Eugene Fama and Robert Shiller.

On its face this multiplicity of views seems incompatible with the hypothesis of rational expectations.  If all agents have access to the same information and the same (correct) model of the economy, then, instead of a multiplicity of expectations, we would see a uniformity of expectations.  Some of this real-world diversity of expectations can, of course, be explained by “information partitions” in which market participants have access to different pieces of the “information pie.”  The force of this explanation is diminished, however, by the broad dissemination of government statistics and the widespread use of information technology to organize and analyze this data.  Moreover, economists with access to the same data and information processing capabilities nevertheless produce conflicting explanations of historical trends and events, divergent forecasts of future trends, and opposing predictions about the effects of various monetary and fiscal policies.

This multiplicity of outlooks, whether in the form of theories, models, beliefs, or expectations, calls into question the usefulness of the postulate that economies are always in equilibrium.  Even if a rational expectations, representative agent, model could be calibrated to track some time series of economic data, it could hardly explain the obvious presence of agents with diverse and, often conflicting, views.  Furthermore, if market participants are acting on the basis of inconsistent expectations, then at least some of these expectations will disappointed and some plans will have to be revised.  To insist on characterizing an economy in which the participants are planning to buy and sell at different prices as being in equilibrium is simply to insist on a stipulated definition come what may. 

In their Anti-Keynesian manifesto, Lucas and Sargent (1979) criticize the lack of microfoundations in the Keynesian models that were developed in the 1950s, 60s, and early 70s.  Many reasons have been offered in defense of microfoundations as a necessary feature of a good macro model, including an implicit appeal to the familiar notion of autonomous agents who form and act upon their own plans and forecasts.  Thus, Lucas and Sargent chastise “economists who ten years ago championed Keynesian fiscal policy as an alternative to inefficient direct controls [now] increasingly favor the latter as ‘supplements’ to Keynesian policy” (original stress).  But it’s the gloss they add to their argument that’s most revealing.  Mocking these old fashioned Keynesians they write, “The idea seems to be that if people refuse to obey the equations we have fit to their past behavior, we can pass laws to make them do so” (original stress).  Free and independent agents keep changing their minds in response to new information, so their “past behavior” is, at best, an imperfect guide to their future behavior.

A closer look reveals that the New Classical demand for microfoundations straddles two incompatible ideas.  On the one hand, Lucas and Sargent insist on microfoundations because they believe economic outcomes depend on the rational choices of individuals rather than on the behavior of aggregates.  What is “the Lucas critique” if not a vigorous statement of this point?  On the other hand, genuinely autonomous agents, who choose their own objectives and the means of achieving them, will often hold different views about the future.  Indeed, this a reasonably good description of what happens in societies when the unquestioned guideposts of custom and tradition give way to some measure of individualism and self-determination.  Thus, while the demand for microfoundations appeals to the idea of independent agents constructing their own action-guiding scenarios, the variety of beliefs that emerge from, and guide the actions of, these agents is suppressed by the premise of rational expectations.  If we really want macroeconomic models that are consistent with free and independent agency, then we need a new “microfoundations of autonomy.”  I’ll return to this topic in a future post.